Co-operative and Community Benefit Societies Act 2014 (Amendments to Audit Requirements) Order 2017

Baroness Kramer Excerpts

Thursday 1st February 2018 Lords Chamber

[Lord Young of Cookham (Con)]

My Lords, these three orders relate to the mutuals sector, which encompasses co-operatives, community benefit societies, credit unions and building societies. In the mutuals sector the interests of members, not shareholders, are paramount. Mutuals are an important part of Britain’s diverse and resilient economy, and we wish to keep it that way. Recognising this, the Government have brought forward a package of measures to provide further support for the sector and level the playing field between mutuals and companies.

There are nearly 7,000 co-operatives in Britain today, which together contribute more than £36 billion to the UK economy. They employ over 200,000 people and are part-owned by 13.6 million members of our society. The Government recognise the value of co-operatives and want to ensure they are not saddled with unnecessary administrative burdens. Since 2012, small companies have enjoyed an exemption from the requirement in the Companies Act 2006 to have their accounts fully audited.

The first statutory instrument, the Co-operative and Community Benefit Societies Act 2014 (Amendments to Audit Requirements) Order 2017, will increase the thresholds at which co-ops are required to appoint a professional auditor from £2.8 million in assets and £5.6 million in turnover to £5.1 million in assets and £10.2 million in turnover, in line with those for companies. While this proposal is deregulatory, noble Lords can be confident that appropriate controls remain in place. Members must vote to apply the exemption and the regulators can still demand a full audit if they have concerns over the management of a co-operative. Furthermore, co-operatives which disapply the requirement to appoint a professional auditor will still be required to prepare a less onerous audit report.

The second of the three orders before the House is the draft Building Societies (Restricted Transactions) (Amendment to the Prohibition on Entering into Derivatives Transactions) Order 2018. Building societies serve over 20 million UK customers and are an integral source of loans to first-time buyers. In order to offer fixed-rate mortgages, building societies must hedge against the risk of interest-rate changes and may do so by buying derivatives. The European markets infrastructure regulation of 2012 requires all derivatives to be centrally cleared. This means that building societies must either become direct members of a clearing house or clear through third-party members.

However, as it currently stands, the legislation prevents building societies complying with the membership rules of the main UK clearing house. The specific rule which we are concerned with requires that, in the event of a member defaulting, other members must bid for a portion of the defaulted member’s derivatives portfolio. Under current legislation, building societies cannot take part in this process because they are prohibited from trading derivatives for any purpose other than to hedge balance-sheet risk. As a result, building societies must clear indirectly through third parties which are members, placing them on an uneven footing as compared to banks. Clearing through third parties incurs expensive broker fees and makes building societies dependent on clearing-house members continuing to offer this service.

This SI will amend the Building Societies Act 1986, which I believe I put on the statute book, to allow building societies to trade derivatives not just to hedge their balance-sheet risk but for the purpose of complying with the membership rules of a clearing house. The Government have consulted representatives of the building societies and the Prudential Regulation Authority in developing these proposals, and they are content.

The last order before the House concerns mutuals in Northern Ireland including, for this purpose, credit unions. Under the Financial Services and Markets Act 2000, mutuals in Great Britain are registered with and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. As noble Lords will recall, prior to the appointment of the FCA as the primary financial services regulator, this function was performed by the Financial Services Authority. Following the failure of Presbyterian Mutual in October 2008, at a cost to the taxpayer of £50 million, Northern Ireland Ministers and HM Treasury agreed that responsibility for regulating Northern Ireland credit unions and other mutuals should transfer to the FSA. Responsibility for regulation was transferred in 2011. The aim of this transfer was to provide members of those mutuals with access to the Financial Services Compensation Scheme and the Financial Ombudsman Service, among other benefits.

It was intended that the registration of Northern Ireland’s mutuals should follow in due course, once the establishment of the new Financial Conduct Authority and Prudential Regulation Authority was completed. It is clearly logical for registration and regulatory oversight to lie with a single authority. The Northern Ireland registering authority, the Department for the Economy, also supports the move. A good deal of preparatory work has now taken place, and Department for the Economy and FCA officials are working closely to ensure that Northern Ireland’s mutuals are supported during the transfer of registration, which is set to occur on 6 April this year. Societies previously registered with the Department for the Economy will not have to re-register; their records will simply be transferred to the FCA.

I trust that the Members of the House will agree that these orders represent a welcome update to mutuals legislation across the country for the wider benefit of the sector. I commend the orders to the House.

[Baroness Kramer (LD)]

My Lords, I have a few questions to ask the Minister on these orders, although I cannot see anything major wrong with them. The first order the Minister described lifts the threshold at which point a co-op is required to have a professional audit. I have two questions on that. Looking through the attendant paperwork, I notice that responses to the consultation came from different co-operative societies. It is no surprise that they would wish to be on a level playing field with their various competitors which are privately owned companies, so I perfectly understand why they feel it is unfair that they should carry a cost burden which their competitors of the same size do not. But there is a difference between a private company and a co-op, which is that the membership of the co-op, which in effect is its ownership, is typically much more widely cast and made up of a large number of people who may not have a great deal of financial sophistication, whereas the owners of a privately owned company may have much greater awareness of the financial structure and happenings within that company. So I wonder to what extent the Government in their consultations took into account the exposure of relatively small people to losses that might seem quite small to those who have very large incomes but might be significant to those who are part of the membership of a co-op. It is the first area of concern.

Secondly, I am curious to understand the choice of benchmark. From the outside, it looks slightly random. I wonder whether it was done on a percentage of size within the industry or whether there was some structural characteristic within the industry that led to the choice of that benchmark.

The second issue the Minister addressed was the provision of the order that would allow building societies to be members of clearing houses. I think that all of us in this House agree that it is crucial that interest-rate swaps are cleared through a central counterparty—in the UK that would usually be the London Clearing House—and that it is very frustrating for building societies and mutuals to have to go the agency route and pay a brokerage fee, usually through an existing member which, quite frankly, is fairly disinterested in the service that it provides to that building society, never mind charging for it—so I am entirely on board. Can the Minister strengthen his confirmation that this provides no capacity for building societies to engage in speculation? It seems to be very clear that it does not. We all recognise that anyone providing a fixed-rate mortgage can do so only if they can hedge it through a derivatives contract, so that is an entirely appropriate and necessary use of a derivatives contract, or by doing it at the level of the balance sheet to achieve the same kind of protection.